Updated economic forecasts for the second quarter of 2011 and quarterly for one year thereafter, will start coming out shortly. Summit Economics contributes to the USA Today consensus forecast. As we reflect of the coming year and a half, the best analogy comes from the healthcare field. How will the patient react once removed from the life support systems known as Quantitative Easing 2 (QE2) and almost a $1.5 TRILLION federal deficit?
The Federal Reserve’s QE2 will end by summer and thus far there is no talk of a QE3. What impact will this have on longer terms asset markets like bonds, stocks, and real estate? Logic tells us asset values should drop a bit initially. In fact, this may have already happened as markets anticipate the future.
Washington agreed to budget cuts totaling almost $40 billion – a drop in the bucket compared to what is needed long-term. More cuts are likely when the debt ceiling is raised. Beyond that, both the White House and Congress appear to be serious about laying out a plan to get the fiscal house in order. Standard and Poors helped out a bit today be mentioning a possible downgrade of U.S. government debt, basically stating “Get the financial house in order.” While these are needed changes, what makes sense for the long-term may send the patient back into temporary shock.
Overall, we were impressed with the magnitude of job gains nationally in the first quarter, especially given fiscal strains faced by state and local governments. The private sector performed better than expected which is great news given the looming changes in life supports. As a result of these recent trends, we have increased our employment growth forecasts, but are sticking with our slightly more pessimistic forecasts of GDP growth staying closer to 3.0% to 3.4% for the first half of the year and then declining over the next year into the mid 2% range. While this is not where we want to be, it’s better than where we were a couple of years ago and demonstrates stability with slow improvement.
We don’t see much change in the unemployment rate in terms of improvement as we move into the second half of this year. With government spending dropping at all levels of government the private sector will have to make up for the difference to sustain growth. Can it?
In addition to the curtailment of support from the Federal Reserve and the federal government, events in the Middle East, Northern Africa, and Japan have increased oil prices. In our prior forecasts we were seeing oil price stability in 2011, but that has changed. Most oil industry analysts see higher oil prices as being the norm long-term. Similar to the other changes noted above, accepting the new reality and getting on with the challenges ahead will be painful on the short-term, but beneficial in the long-term as the U.S. changes its energy portfolio and focuses more on production closer to home using both traditional fossil fuels and new emerging technologies.
Given this reality, the economy could face a triple whammy – lower asset prices due to no more quantitative easing, less government spending, and higher energy prices. These likely events will stymie consumer spending which leaves private non-residential investment and export growth as the two primary sources of pushing GDP higher.
What’s the good news? Housing price declines seem to be waning and could be at the bottom. Regions in the U.S. with oil and gas will see increased investment and job growth. Innovation in the automotive industry in terms of fuel efficiency may lure buyers back into that market. The agricultural sector is booming. U.S. manufacturing continues to improve. Inflation, which will be significantly higher due to volatile energy and food prices, will remain low at its core (due to a weak economy). The Millennial generation is entering the labor force in large numbers helping drive up consumer demand as Baby Boomers lower consumption while preparing for retirement in an increasingly uncertain world.